Accounting Discretion, Loan Loss Provisioning and Discipline of Banks' Risk-Taking
48 Pages Posted: 11 Dec 2009 Last revised: 17 Jan 2013
Date Written: April 25, 2012
Examining banks across 27 countries, we estimate two measures of the forward-looking orientation reflected in discretionary loan provisioning practices within a country. We document that forward-looking provisioning designed to smooth earnings dampens discipline over risk-taking, consistent with diminished transparency inhibiting outside monitoring. In contrast, forward-looking provisioning reflecting timely recognition of expected future loan losses is associated with enhanced risk-taking discipline. Thus, proposals to change loan loss accounting embed significant risks of unintended consequences, as gains from reducing pro-cyclicality may be swamped by losses in transparency that dampen market discipline and increase the scope for less prudent risk-taking by banks.
Keywords: Smoothing, Timeliness, Accounting Quality, Loan Loss Provisions, Discretion, Risk, Banks
JEL Classification: E58, G21, G32, M41
Suggested Citation: Suggested Citation